Turnover and Taxes of Funds
Many investors own mutual funds, but few of them realize how much they really earn after taxes. Here’s a little insight from Creating Equity by John Bowen. In a study commissioned by Charles Schwab and conducted by John B. Shoven, professor of Economics at Stanford University, and Joel M. Dickson, a Stanford Ph.D. candidate, taxable distributions were found to have an impact on the rates of return on many well-known retail equity mutual funds.
The study measured the performance of 62 equity funds for the 30-year period from 1963 through the end of 1992. It found that the high-tax investor who reinvested only after-tax distributions would end up with accumulated wealth per dollar invested equal to less than half (45%) of the funds’ published performances. An investor in the middle-tax bracket would see only 55% of the performance published by the funds.
Another study, by Robert H. Jeffrey and Robert D. Arnott, published in the Journal of Portfolio Management, concluded that extremely low portfolio turnover can be a factor in improving a fund’s potential after-tax performance. Asset class funds typically have very low portfolio turnover, which translates into less frequent trading and, therefore, may result in lower capital gains. Low turnover also may benefit shareholders by holding down trading cost.
In plain English, the above studies indicate that you can lose a lot of your returns from mutual funds to taxes and that funds with high turnover tend to generate higher taxes for you. You can find out how tax efficient your funds are by consulting information services available in many local libraries or consulting a financial advisor experienced in the tax issues of mutual funds.
